Editorial: When Wall Street Made Both Dollars and Sense

There was a time when the stock market was a somewhat reasonable place. People invested in companies that they believed had a good product, or perhaps a good idea for a product or service, and their investment provided the capital to grow and expand. Investors generally received a dividend and their re-investment (or not), largely signaled their level of approval in the company’s management and vision.

One of the first gross departures from that relatively simple structure was a switch from values being associated with dividend per share to profit per share. It’s true that dividend per share is sometimes an imperfect indicator of a stock’s value. For instance, some industries require excessive research and development reinvestments that can be deceiving in that regard.

However, with earnings per share, we inherited a sometimes less exact and infinitely more easily massaged manner of assessing value. Suddenly, accounting mega-firms like Arthur Anderson became an extremely important and valuable friend of the publicly-financed corporation, profiting at the invention of creative methods of accounting, designed to optimize the perception of value rather than its realization.

Because large corporations had also begun to compensate their CEO’s and other top executives primarily through stock related bonuses -- the share price, and therefore value ”perception“ -- suddenly became of even greater importance to corporate leaders. If a CEO could manipulate that perceived value in the short term, he or she could potentially reap hundreds of millions of dollars in compensation, even by making terrible long-term decisions that were not in the best interest of their company, its employees, or its long-term shareholders.

True, this could eventually lead to the CEO losing their job, but if they’ve already profited enough to live lavishly through several lifetimes, how much risk lies in such dismissal? One of the many negative aspects that this sort of system promoted was that daily operations of many companies, all the way down to entry-level employees, tended to center less around what that company did to make a profit, than it did on practices that would affect analysts’ perception of the stock’s value and this hurts the economy as a whole.

Enron, Worldcom, and Tyco are well-known and more extreme examples of stock prices having little or nothing to do with sustainable profitability (until it was too late) and I think it should be no surprise that it was around this time that many of the current stock purchasing innovations we see today began to take form. When investors begin to lose complete faith in the institutional soundness of the exchanges, speculating in stocks becomes little more than a casino gamble, and many emerging technologies for purchasing stocks reflected that, by placing very little value on the company itself, or any indicators for its long-term success.

The recent New York Stock Exchange swing, in which companies rose and fell by inexplicable and potentially catastrophic margins, was said to have been caused by a confluence of technologies unintentionally interacting with each other, triggering lightning fast mega-trades directed by computer software protocols. Hyper-trading and algorithmic trading are processes in which billions of shares can be traded in a matter of seconds. Not by the standard method of traders analyzing shifting markets and executing educated transactions, but by mathematical formulas that automatically execute trades based on price points, market movements, order quantities, and other factors that change almost constantly.

What was perhaps most disconcerting was the admission that virtually no one could seem to explain precisely what happened or exactly why. It gave me no comfort to think that we know so little about how such potentially influential products work, and it felt eerily similar to finding out how little was known about many of the mortgage instruments that nearly sunk our entire economy. It also served to demonstrate the potential magnitude of cyber-terrorism and did nothing to inspire trust that such threats are adequately guarded against. If computer programs could cause that to happen by accident, it seems plausible that they could be engineered to do the same for nefarious purposes. 

While a high volume of trades can provide vital liquidity in markets, it is important to note that such calculated decisions even further reduce the tangible aspects of why trades are made, what such decisions reflect in the market, and perhaps most importantly, any sense that the average investor is participating in a fair process, on a level playing field. What is the sense in following a company, reading research data, and considering sector forecasts, when so little of what happens to a given stock on any day of trading could have to do with such benchmarks?

The stock exchanges have always been an intrinsic element of our financial systems and that is unlikely to change. They are an essential component from which companies can raise capital quickly and innumerous corporations have benefited from their existence, as has our economy as a whole. It is for this reason that it is so terribly important to closely regard such fundamental changes in the way their business is conducted. If we fail to instill a sense of fair and regulated investment, rather than that of a high-stake table game, the NYSE might soon find more of its competition for peoples’ capital coming from Las Vegas than NASDAQ.